NY futures continued their downtrend this week, as May gave back another 79 points to close at 76.77 cents.

The market continues to drift lower, as the March contract is approaching convergence with the cash market, which we feel will take place at around 74-75 cents. March has been dragging the back months down with it, but we feel that we are not far from a bottom.

Again, we see a lot of similarities to last season, when the March contract traded as low as 73.02 cents ahead of the notice period, while May reached a low of 75.05 cents. Thereafter May and July would trade in a mid-70s to mid-80s range for the following three months, supported by mill fixation buying and a lack of spec selling.

While mills have clearly won the first round of this fixation game against speculators, there are still two more rounds to go, with 3.51 million bales left to fix on May and 4.15 million bales on July, for a total of 7.67 million bales. A year ago, we had 3.99 and 3.46 million in unfixed on-call sales on May and July, for a total of 7.45 million bales.

The big question is whether the trade will find the necessary sell-side liquidity to get all these fixations done without forcing prices higher again. Thanks to speculators liquidating about 4.0-4.5 million bales of their net long since January 23, mills got lucky with their March fixations, but will speculators continue to let them out of trouble going forward?

Last season speculators were still 12.37 million bales net long on February 14, while right now we estimate the spec net long to be at just around 7.5-8.0 million bales. In other words, there is already a lot less potential liquidity available from speculators, yet unfixed on-call sales are as large they were a year ago.

When we look at the market from the specs’ perspective, there are quite a few reasons for them to stay invested on the long side. Inflation is clearly picking up as evidenced by the most recent CPI data, while the US dollar continues weaken. A year ago, the US dollar index was at 100.50 and today it closed at 88.62!

Since commodities are seen as an inflation hedge, we don’t see the remaining spec long being shaken out that easily. By hanging around after an 800-point drop, which violated several trendline and support levels, speculators have already demonstrated that they have staying power. This could spell trouble for the many trade shorts that depend on continued spec liquidation in order to get their shorts covered.

US exports maintained their frantic pace of sales last week, as a combined 498,400 running bales of Upland and Pima cotton were sold to 19 different markets. China was the leader of the pack with 105,300 running bales net. Despite some logistical difficulties, shipments of 342,500 running bales were near the weekly average needed to make the USDA export projection of 14.5 million bales by the end of July.

Total commitments for the season have now reached 13.4 million statistical bales, of which a little over 5.5 million bales have so far been exported. This compares to 11.0 million bales and 6.1 million bales a year ago. New crop sales of 1.9 million statistical bales are about a million bales ahead of last season.

When we look at the US balance sheet, we started with a total supply of 24.0 million bales (2.75 beginning stocks + 21.25 crop), of which 16.75 million bales (13.4 export + 3.35 domestic) have already been committed. This leaves just 7.25 million statistical bales for sale, with still around 7-8 months to go until new crop starts filling the pipeline again.

So where do we go from here? The fact that mills were able to get out of March fixations with relative ease, thanks to specs liquidating about a third of their net long, might lull them into a false sense of security in regards to their upcoming May and July fixations.

As explained above, the trade requires sell-side liquidity in order to get its fixations squared away, along with other shorts that need to get covered. The trade hasn’t been very aggressive with fixations lately and let the marked drift lower into the convergence zone as we head into the March notice period. However, sooner or later mills will have to come back to the market and then it will be interesting to see whether they find enough selling to accommodate them.

We feel that the market is close to a bottom and expect a rebound once March is liquidated.

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